The market trades in trends, either up, down or sideways. As traders we have to decide when we should enter or exit on any given trend. Skilled traders have rules and methods for trading. But newbies try to ride the wave of momentum hoping to get out before the turn. Whether new or experienced, all traders are participating in the same move and the profit/loss in the end will show who had better timing. After all, every trend comes to an end.
Early in my trading career I realized that if a trader can avoid going long at the top or short at the bottom he/she can prevent some of the big losses that happen to traders over the course of their career. I believe that big losses affect the traders’ psychology over time causing them to miss out on big opportunities when they present themselves. For example: ABC stock is trending up and looks strong. The trader decides to buy and it continues to go up. Then the price spikes up making a new high and instantly begins to come down below the trader’s entry price. The trade begins to go negative very quickly and seeing this the trader exits the position at a loss. This example, although basic, describes the experience of many traders throughout their trading career.
There are 3 reasons traders make the mistake of trading either the top or bottom of a trend.
# 1 Patience. For some traders it’s their lack of patience which causes them to react to every quick move in the market.
#2 Fear. For others it is the fear of missing out which grabs them and forces them to take unnecessary risk.
# 3 Greed. The father of them all is greed because it lures the trader into thinking they can make quick profits.
In each case the trader’s psychology is not balanced. Traders must learn to be in neutral and not be taken in by the market through their emotions. The trader shouldn’t be in fear or greed but willing to accept whatever the market gives to them. This acceptance allows the trader to not “chase” the market but wait for it to come to him or her. The traders who understand this balance don’t burn themselves out trying to make every “big move” a “big trade”. Now that I’ve explained some of the psychological reasons traders buy at the top or sell at the bottom let’s look at ways to avoid this when we look at charts.
Here are the 3 most common hints that the trend may be slowing or about to reverse.
Hint # 1 Is the price slowing down? The price slowing down is a good sign that the trend may be over. If the stock was moving .05 to .07 cents and begins to move .02 to .05 cent per 5-minute bar, then that’s a sign it is slowing down.
Hint # 2 How many candles of the same color? If the market produces 4 or more bars of the same color it is more likely to reverse. The reversal might be just a small pullback of the opposite color.
Hint # 3 Is it near a reversal time? Traders should be aware of the reversal time intervals throughout the day. These intervals are also a warning sign at the top or bottom of a trend. A stock is more likely to pullback or reverse in the first few minutes of an hourly or 4-hour chart.
These are just some of the keys hints to look for when trading trends at the top or bottom. Most important is the trader’s psychology. A trader must be in neutral and willing to accept whatever the market gives them in order to clearly see the technical chart patterns.